A hollowing middle class

In many countries, the middle class is feeling squeezed, and the crisis has only made matters worse. What is behind this sentiment and what can be done to reverse it?

Aristotle said it more than 2,300 years ago. “Great then is the good fortune of a state in which the citizens have a moderate and sufficient property; for where some possess much, and the others nothing...a tyranny may grow out of either extreme. Where the middle class is large, there are least likely to be factions and dissensions.” The great philosopher’s words, set down in his treatise Politics, are as true today as they were then. The middle class— whether in developing or developed countries—is the group of citizens most likely to “have a greater share in the government” and so helps to guarantee political stability.

Yet the inexorable rise in inequality over the last 20-30 years is winnowing out the middle in many economies, and tensions are rising around the globe. From the revolutionaries of the Arab Spring, to the protestors setting up camp on Wall Street, it is hard to ignore the voices of those who feel they have been deprived the gains of growth.

A study of 10 advanced economies over the last 40 years by Britain’s Resolution Foundation shows their complaints are not unjustified. The relationship between the pay of ordinary workers and overall economic growth appears to have broken down in each of the countries studied. To different degrees, median pay has lagged growth in GDP in almost every country. The main cause is a sharp and growing rise in pay inequality, to the benefit of the very rich, while the gap between the lowest paid and those in the middle has been decreasing.

The trend in rising inequality has been particularly noticeable in the English-speaking countries where strong growth in the financial services sector has encouraged a shift in compensation away from wages and towards bonuses and options. In the US, statistics show that between 1979 and 2007 the top fifth of the population took an extra 10 percentage points of total after-tax income, with the vast majority going to the top 1%. Everyone else saw their share fall by 2-3 points.

The share of wealth claimed today by the top 1% of American citizens is back to levels not seen since the roaring 20s. In the UK, the High Pay Commission has warned that if current trends continue, the disparity of income between the top 1% and the rest will hit levels not seen since Queen Victoria sat on the throne. Meanwhile, the Institute for Fiscal Studies predicted that in 2011 median income would suffer its largest drop in 30 years.

Pay inequality may have begun to rise sharply in the US and UK in the 1980s, but the phenomenon has since gone global. The rise in income inequality and relative poverty has affected more than three-quarters of OECD countries during the past 20 years, according to OECD reports Divided We Stand: Why Inequality Keeps Rising (2011) and Growing Unequal (2008). Professor John Van Reenen, director of the London School of Economics’ Centre for Economic Performance, argues this is in part due to technological change. New technology has tended to help the highest skilled, such as lawyers, accountants and economists, to be more efficient, and demand for their skills remains high.

However the rapid changes brought about by new technology are hollowing out the lesser skilled routine jobs such as bank clerks or public sector workers—the ones who counted on their steady jobs to fund their children’s education and a hopefully comfortable retirement. “In all OECD countries ‘middle class’ occupations appear to be shrinking relative to those in the bottom as well as the top third,” says Mr Van Reenen.

Some economists have argued that the shrinking middle is not all bad news, if more families are moving up the ladder than down. Yet polarisation of the workforce and growing inequality as the rich get much richer nonetheless raises urgent questions for policymakers, particularly as they struggle to stimulate growth. The issues are as pressing for developing countries such as China and India where, despite a rapidly growing middle class, inequality has also been on the rise.

William Easterly, the US economist, writing for the World Bank in 2001 found that middle income share affects all indicators such as life expectancy, infant mortality and health outcomes. A middle class consensus is also good for democracy, he argues, with research showing that a rise in middle class share has a clear impact on development of political rights. Elite dominated societies, he adds, will also invest less in human and infrastructure capital for the majority because of “fear of empowering groups outside [its] own class”.

The middle class is a constituency that policymakers ignore at their peril. The key will be to ensure that the traditional aspirations of the middle class—a job, education for their children and a secure retirement—are not rendered futile as governments seek to control public spending while boosting growth. That, of course, means pursuing job creation policies. But in a world where technology has ruthlessly culled middle income opportunities, policymakers will also have to ensure that the skill sets of the middle class match the needs of employers, which means prioritising education above almost all else. Focusing on lifelong learning and skills enhancement must be a priority, as the wage premium for education has clearly grown.

It is also notable that the Resolution Group study found that countries with the greatest disconnect between growth in the economy and median wages were those where unions and collective bargaining were weakest. Encouraging a working dialogue between labour and employers could help to stem in inequality.

Finally, policymakers must do more to halt the accumulation by an extreme minority of an ever greater share of their nation’s wealth. This means doing more to rein in the culture of excessive bonuses that has flourished in recent years. Progressive fiscal policies will also ensure that the burden of maintaining public services such as health and education—which have the greatest effect on income inequality and relative poverty—are more fairly shared. This will not only bolster the middle class but benefit the poorest as well.

As Aristotle said more than two millennia ago, no government should be content with a nation “of masters and slaves, the one despising, the other envying”. Everyone’s interests are best served when the population has a healthy middle class. “This is the class of citizens which is most secure in a state … and as they neither plot against others, nor are themselves plotted against, they pass through life safely.”

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